When the ECB cut its main rates by a quarter of a percentage point to below 1% last Thursday, the central bank also lowered the deposit rate from 0.25% to zero, resulting in a significant reduction in yields in the European money markets. Fund providers who monitor these markets daily make – sometimes severe – decisions based upon what they deem best for their shareholders.
As such, J.P. Morgan and Goldman Sachs have temporarily closed some of their portfolio European money market funds (MMFs) to new investments. This presents challenges for MMFs managers in the euro environment, according to a statement from the Institutional Money Market Funds Association (IMMFA). Yet the subscription restriction decisions taken by the two leading MMF providers are not unprecedented.
“As an industry we have experienced similar conditions in the US market towards the end of 2008 when USD rates fell to very low levels. Some US and European US dollar-denominated funds decided to limit subscriptions to their USD funds at that time. In late 2011 when yields on core Eurozone government were negative, some euro-denominated MMFs decided to restrict subscriptions to protect investors,” says the trade association.
Nor do these fund limitations equate to a restriction on redemptions as shareholders are still permitted to redeem from MMFs as normal, reads the IMMFA report. This banishes the fear then that fund managers are simply attempting to prevent a run on euro MMFs by enforcing this embargo. Rather, they are simply unable to appropriately invest new monies to gain a reasonable return for their prospective clients.
So, in light of the recent rate changes, will some euro-denominated investors be encouraged to look towards USD short-term markets in a search of yields – or indeed access? We might not see a flight of this sort for the moment. The key thing to focus on is the type – particularly the size – of the funds that are being closed, according to Andrew Tunks, Head of Money Markets, Currency and Risk Oversight at Scottish Widows Investment Partnership.
“In terms of the euro market, in the medium term, it is still possible to run medium sized funds appropriately and efficiently. The problem now is that a capacity issue is beginning to show itself within the euro market,” he says.
Furthermore, Tunks believes that the priorities of the investor have changed in recent years as the market itself has developed. “The client is not solely focussed on yield. The client uses MMFs for diversification purposes in such a way that they can leverage off the credit analytical capability of the managing house. They will also be looking at the liquidity aspects of the fund. Return is obviously very important but it isn’t the only driver for investors,” he says.
Luckily enough it seems, as Tunks does not expect the current market environment to change significantly. “An era of ultralow rates to zero is something that we have all got to come to terms with – both asset manager and client. We need to adjust our strategies accordingly,” he says.
This sentiment is backed by the comments of the ECB president Mario Draghi to the European Parliament on Monday (July 9th 2012) which suggest further measures – such as more cuts to the benchmark rate and negative deposit rates – are a possibility. With some banks already allocating a negative yield to their deposits, the markets simply need to come to terms with frugal returns wherever they invest.